Let’s Talk About Gold’s Flash Crash

On Monday morning, there was extremely unusual price action in the gold market. Gold futures started the morning relatively flat at around $1,240/ounce. As the stock market in the U. S. opened, gold futures began to climb higher — reaching nearly $1,250/ounce, a strong psychological resistance level. After retreating for a few minutes back towards $1,245, the market just collapsed. At 10:14 am Eastern Time the gold price fell as low as $1,211.86 before rebounding sharply off this level.

The following chart, provided by NetDania, illustrates the severity of the decline. Note that the times on the bottom are Central Time. What was especially unusual about this is the fact that this only happened to gold. Even silver, which often moves in tandem with gold in an exaggerated fashion only saw a decline of 1.5 percent.

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What happened?

CNBC producer Alex Rosenberg interviewed Matthew Hoverman of Grafite Capital who claims that a “fat finger” trade lead to the decline, meaning that a large institutional trader put in a large order to sell gold futures that was simply too much for the market to handle. This caused an initial decline that forced other traders to abandon their positions, which leads to a cascade of selling.

However, there is no evidence to support Hoverman’s claim. If Hoverman is correct, then we would expect to see a significant amount of trading volume going into the decline. But if you look at the chart, you will see that volume — represented by the blue bars on the bottom — is rather light going into the decline. In fact, it is shrinking. After the decline we see a spike in trading volume. While this invalidates Hoverman’s theory it leaves us wondering what happened. Maybe there was just a rare moment in which buy-side volume exited the market for whatever reason. The fact of the matter is we really don’t know.

One piece of information that can tell us something is the fact that volume spiked markedly after the price collapsed. This shows a willingness on the part of traders to buy gold on declines and it is indicative of a potential change in sentiment among gold traders from bearish to bullish. This point is corroborated by the fact that gold is now up slightly on the day — trading at just over $1,240/ounce — which means that this morning’s aberrant price action did not perturb investors and traders. I think this is a very promising development for gold bulls.